From Income to Wealth Inequality in the US: General Equilibrium Matters


The past 40 years have been characterised by a decrease in the rate of return on safe assets, an increase in the equity premium, an increase in the price of financial assets, and an increase in labor income and wealth inequality. Using a heterogeneous-agent model featuring permanent labor income inequality, a two-asset structure, and non-homothetic preferences, we investigate the impact of an increase in permanent labor income inequality on wealth inequality. As rich households save a higher share of their permanent income than poorer ones, a more skewed permanent labor income distribution increases aggregate savings. With imperfect competition, a higher level of savings leads to a higher valuation of firms and a limited increase in the capital stock. The induced capital gains increases wealth inequality due to portfolio heterogeneity.